# Question

Using the model in File C11, rework Problem 11-27, assuming that a third stock, Stock C, is available for inclusion in the portfolio. Stock C has the following historical returns:

Year Stock C’s Return, ¨rC

2011 ......... 32.00%000

2012 ......... 11.75000%

2013 ......... 10.75000%

2014 ......... 32.25000%

2015 ......... 6.75%000

a. Calculate (or read from the computer screen) the average return, standard deviation, and coefficient of variation for Stock C.

b. Assume that the portfolio now consists of 33.33 percent Stock A, 33.33 percent Stock B, and 33.33 percent Stock C. How does this composition affect the portfolio return, standard deviation, and coefficient of variation versus when 50 percent was invested in A and in B?

c. Make some other changes in the portfolio, making sure that the percentages sum to 100 percent. For example, enter 25 percent for Stock A, 25 percent for Stock B, and 50 percent for Stock C.

d. In Problem 11-27, the standard deviation of the portfolio decreased only slightly because Stocks A and B were highly positively correlated with each other. In this problem, the addition of Stock C causes the standard deviation of the portfolio to decline dramatically, even though σC = σA = σB. What does this change indicate about the correlation between Stock C and Stocks A and B?

e. Would you prefer to hold the portfolio described in Problem 11-27 consisting only of Stocks A and B or a portfolio that also includes Stock C? If others react similarly, how might this fact affect the stocks’ prices and rates of return?

Year Stock C’s Return, ¨rC

2011 ......... 32.00%000

2012 ......... 11.75000%

2013 ......... 10.75000%

2014 ......... 32.25000%

2015 ......... 6.75%000

a. Calculate (or read from the computer screen) the average return, standard deviation, and coefficient of variation for Stock C.

b. Assume that the portfolio now consists of 33.33 percent Stock A, 33.33 percent Stock B, and 33.33 percent Stock C. How does this composition affect the portfolio return, standard deviation, and coefficient of variation versus when 50 percent was invested in A and in B?

c. Make some other changes in the portfolio, making sure that the percentages sum to 100 percent. For example, enter 25 percent for Stock A, 25 percent for Stock B, and 50 percent for Stock C.

d. In Problem 11-27, the standard deviation of the portfolio decreased only slightly because Stocks A and B were highly positively correlated with each other. In this problem, the addition of Stock C causes the standard deviation of the portfolio to decline dramatically, even though σC = σA = σB. What does this change indicate about the correlation between Stock C and Stocks A and B?

e. Would you prefer to hold the portfolio described in Problem 11-27 consisting only of Stocks A and B or a portfolio that also includes Stock C? If others react similarly, how might this fact affect the stocks’ prices and rates of return?

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